Higher Taxes on Top Earners Hurt Chances for Lower Taxes on Business

Despite bipartisan desire to help U.S. business compete better against foreign rivals with lower taxes, the window appears to be closing for a comprehensive revamp of how business is taxed.

The New Year’s deal to avoid the “fiscal cliff” averted a potential economic catastrophe, but it also changed the equation on which calls for overhauling the corporate tax code were based.

As recently as 2008, about 12 percent of federal revenue came from corporate taxes, according to the nonpartisan Congressional Budget Office. Most corporations don’t pay the 35 percent rate — the highest corporate rate in the developed world, except for Japan — but take advantage of tax breaks to bring that down to an average of about 25 percent.

During his 2012 campaign, President Barack Obama supported lowering the corporate tax to 28 percent. His vanquished rival, Mitt Romney, wanted it down to 25 percent. Both men pledged to close loopholes so that the lower rates would actually bring in more tax revenue.

Those proposed changes, however, were part of a vision for a broader tax revamp.

“The enthusiasm for moving that rate down is going to be nonexistent by the administration. And moving tax reform with no help from the administration is going to be very difficult,” said Catherine Schultz, vice president for tax policy at the National Foreign Trade Council, a lobby for multinational corporations. “There is not a lot of incentive for the Obama administration to move forward on comprehensive tax reform.”

The White House didn’t reply to requests for comment, but Obama briefly mentioned revamping the tax code in his inaugural address.

Before the New Year’s budget deal, updating the corporate tax code was a bargaining chip to dangle in front of Republicans in what many thought might be the first comprehensive overhaul of taxation since 1986.

But this all depended on the income tax cuts that were expiring Dec. 31 being extended for another year while Congress engaged in a “grand bargain.” The equation changed once the president got the higher taxes on households with taxable income above $450,000, raising the rate from 35 percent to 39.6 percent.

The chairman of the tax-writing House Ways and Means Committee, Michigan Republican Dave Camp, wants the corporate tax rate to be equal to the top individual tax rate. That’s now unlikely, given that Obama, after working for years to raise the top tax rates, is unlikely to agree to lower them.

Tax legislation originates in the House of Representatives, and an aide to Camp, demanding anonymity in order to speak freely, insisted that comprehensive tax restructuring was still in the cards.

“The chairman has said pretty explicitly that there is nothing … that changes our mind-set or our mood about comprehensive tax reform,” the aide said. “It’s almost as though if you like the economic environment we’re in today, then stick with the current tax code.”

In the Senate, Finance Committee Chairman Max Baucus, D-Mont., also still envisions a broad overhaul of taxation.

There’s a reason both chairmen insist on a comprehensive approach: About three-quarters of U.S. corporations don’t pay corporate income tax. Rather, their owners or shareholders claim the business income on their individual tax forms.

It’s why it’s nearly impossible to do a corporate tax revamp alone. Trying to overhaul corporate taxes alone would mean that all but the largest corporations would fall outside of the effort.

Because the new higher individual top income-tax rates were made permanent in the New Year’s deal, the baseline on which all tax calculations are made is fixed. In order to get the rates down from 39.6 percent to 28 percent, the tradeoff in closing loopholes to make up for lost revenue would require almost completely eliminating popular tax deductions for mortgage interest, state taxes, charitable giving and employer-sponsored health care, among others.

“The number of things they would have to do is so painful, it’s going to be very hard to move forward on that,” Schultz said.

Still, the spokeswoman for the Senate Finance Committee saw a reason for hope in the New Year’s deal: There’s no longer debate over which assumption to work off of.

“Talks have previously broken down over that. It’s tough to do tax reform if you don’t know where you are starting out from. I think a lot of people in the tax world saw that as a big step forward,” Smith said.

Business groups acknowledge that their agenda now faces a steeper slope.

“Before the election last fall, the business community knew that tax reform was going to be very challenging. If you look back to 1986, it was killed numerous times before success,” said Matthew Miller, a vice president of the Business Roundtable, the lobby for corporate CEOs.

Added Dorothy Coleman, vice president of tax policy for the National Association of Manufacturers, “From our perspective, we feel very strongly we need to reform our tax code. … We know it’s difficult. It’s never easy, but we still — before and after the fiscal cliff — feel this is something very important to do. We’re not backing down from it.”

There may be room for a smaller rework of corporate taxes. Trade groups are pushing for a change that would have corporations pay taxes only on the income they’ve earned in the United States, a concept known as a territorial tax system.

That would be simpler to navigate than the complicated method of paying taxes in the United States on income earned anywhere in the world, then subtracting what they’ve already paid in taxes in foreign countries where the income was earned.

Commission members thought that a lower corporate tax rate would encourage companies to stay in the United States and would offset any incentive from the territorial tax approach to shift production abroad.